EU break-up back on table; see Greek exit in 12 months: NAB

Nick Parsons of National Australia Bank sees Greece exiting the European Union within the next 12 months, bringing the possibility of a EU break up back on the table.

Nick Parsons of National Australia Bank sees Greece exiting the European Union within the next 12 months, bringing the possibility of a EU break up back on the table.

In an interview to CNBC-TV18, Parsons explains that if Greece’s extreme right party comes to power, they will renegotiate Greece’s membership of the EU. “Given that the bailout package was negotiated last year, there is a going to be considerable uncertainty in that market over the course of the next few weeks,” he added.

The possibility of an EU break up was diverted last year with various measures such as the long term refinance operations (LTRO) and the restructuring of Greece’s debt.

Even though the break of the EU is a negative event, Parsons believes it will ultimately lead to a stronger euro instead of a weak one. “We believe the euro will end this year 2012 stronger than it is today and stronger than it was at the beginning of the year,” he said. His level for the euro at the end of 2012 is 1.36 to the dollar.

While he is positive on the euro, Parsons has a negative view on equities. “We are less optimistic about earnings power, business and consumer confidence and about the ability of the European economy to recover quickly, so yes, equities we still think have got further downside,” he explained

Below is an edited transcript of his interview with Latha Venkatesh and Gautam Broker. Also watch the accompanying video.

Q: What have you made of the weekend events in Europe? We have seen some losses in the DAC and the CAX, but things appear to have stabilized. Do you see much more in terms of losses?

A: We have seen losses extending to around 1.5% in the major markets. It’s worth noting that Greece is down 6.5% on the day, making it down in year over year terms. So it’s the biggest daily fall in nearly five years for the Greek market.

Q: Do you think the new democracy will manage to pull off a coalition by the end of this week? Will we have some positive news flow from there or is it very unlikely?

A: I think the Greek election result appears in financial market terms to be the worst of all possible worlds. Not only have the two main parties been decimated, but we have also seen some of the extreme parties, notably the far right gaining representation in Parliament for the first time. The far right vote rose from less than 0.5% to almost 7%.

Given that they have pledged to renegotiate Greece’s membership of the EU and also the bailout package that was negotiated last year, there is a going to be considerable uncertainty in that market over the course of the next few weeks.

Q: The events of the past six months, the long term refinancing operation (LTRO) and before that the second bailout for Greece, had erased fears of the euro breaking up and someone like Greece walking out. Is that back on the table now?

A: I think Greek exit from the monetary union is very much back on the table and personally I wouldn’t be surprised if that were to happen within the next 12 months. However, we believe that a Greek exit would be an event that would ultimately prove to be a positive for Europe. It would lead to a change of policy from the center, it would lead to a circling of the wagons - they would have to protect what was left - and I think we would ultimately emerge from that process with a stronger euro, not a weaker one.

Obviously it’s going to be very difficult and very volatile getting from here to there, but we don’t believe that a Greek exit from the euro would be disaster for the single currency. In fact, to the extent that it removes that uncertainty and it allows us to move forward, we believe that that actually would be a positive rather than a negative.

Q: Getting to France, Hollande has won his first major hurdle but he also has the Assembly elections in June. Till then, do you think the rhetoric will continue and the newsflow will not be positive for financial markets or do you see the tone that he used yesterday continue for sometime?

A: The French elections were remarkable, not least for the turnout, there was 81% turnout. It was closer than actually many people had considered - 51% to 48.5% for Hollande. I think his programme in office is going to be less dramatic than his rhetoric during the election campaign. But I think we are going to see quite a lot of tension between France and Germany over the course of the next few weeks.

Now ultimately, we think that the focus on growth is going to be a positive for the country and for Europe as a whole because the austerity led growth is quite simply a contradiction in terms. So we need to have an alliance, rather than a coalition, of the sovereign states of Europe along with France. This is especially as Germany faces its own federal elections next year, where Chancellor Merkel may well have to form a grand coalition with the Left Wing in Germany. So I think we are going to see an emphasis on growth, which will be very welcome.

So our take on this is that we are going to see four-six weeks of possibly extreme volatility and we may well over the next twelve months see the Greece will leave the European single currency. But what is left of the euro, we think is more likely to strengthen not weaken over the course of the next year.

Q: Can you put some numbers to the extreme volatility? For instance, for the euro itself, one wouldn’t call 1.30 a major downside from 1.31-1.32 it was trading for the better part of the last three months. Will we see major reverses on the euro-dollar?

A: I don’t think so. Let us remember when the euro was launched in 1999, it started at a rate of 1.18. Its average rate in the last 13 years has been 1.21, so it is hardly trading weak at 1.30.

We think that the downside is limited till mid 1.20s; we may have a test of this year’s low on 1.2665 at some point over the next few weeks, but we are sticking with the view that the euro will end the year at 1.36. We believe the euro will end this year 2012 stronger than it is today and stronger than it was at the beginning of the year. We may well see 5-6 cents lower in the meantime, but those are levels for longer-term investors to be buying the euro, not to be selling it.

Q: But you are less sanguine about the equity markets in Europe?

A: Yes we are less sanguine about those because I think the real concerns about business, consumer confidence and about earnings power going forward. Until very recently, the mood in the markets was that the slowdown in China would be offset to some extent by ongoing and strengthening recovery in the United States. Recent figures have cast considerable doubts on that picture and I think the worries over earnings power and then the sustainability of corporate earnings are going to prove a drag on equity markets from hereon in.

Let us remind ourselves that the euro stocks index is now down year-over-year, it is down 4.4% from January. In France, the CAC is down 1.5% from January 1 and in Spain the market is down 21%, so I think investors have already had the wind taken out of their sails.

Germany and the UK are the only two major markets which are in positive territory and even there we expect to see slippage from here. So we are much less optimistic about earnings power, about business and consumer confidence and about the ability of the European economy to recover quickly. So yes, equities we still think have got further downside.